We came away from the meeting with management still feeling OPTIMISTIC on the group’s mid-term prospect. While 4Q16 could still be partly plagued by labour issues, operations have improved gradually with 1Q17 expected to see it normalized efficiency. Meanwhile, its mid-term prospect will be anchored by new pipeline projects that will be sufficient to offset the STB sales shortfall, even on very conservative assumptions. Post earnings revision (FY16E/FY17E CNP: +18%/null), our TP remains unchanged at RM2.40. Maintain OUTPERFORM.

More details on the 3Q16 results. In addressing the concerns of the group’s short-term prospect, management shed more lights on the underlying weakness in 3Q16. We gather that the exceptionally weak 3Q16 results were mainly caused by the labour shortage issue as well as poorer-than-expected labour quality. With these factors causing higher wastage (thus leading to lower yield) coupled with unfavourable product mix (due to the absence of STB box-build business as well as a gestation period from new product ramping), 3Q16 CNP saw a dip of 59% QoQ and 78% YoY.

A better quarter ahead. While the abovementioned unanticipated phenomena caught us with negative surprises, we are more reassured with 4Q16 prospect as the labour issues have largely been resolved. Note that besides the newly allocated headcounts quota obtained by the group (with recruitment to start from 1Q17), yields have also seen improvement since end of September. Additionally, as mitigation, the group has also reallocated part of orders to its Thailand plant. While all these could cause a temporary blip to the group’s profitability, we believe that the share price has fully priced in the negatives. From the meeting, while management kept their lips tight on the 4Q16 performance thus far, our back-of-theenvelope calculations (based on the end of September’s efficiency) suggest that our forecast for 4Q16 might be overly pessimistic. Hence, post meeting, we have raised our FY16E NP by 18% to account for higher operational efficiency to reflect the potential recovery.

Turning point in FY17. While FY16 appears to be a muted year for the group as mentioned above, the group’s efforts in nurturing growth with existing major clients and cultivating new customers came just in time to offset the earnings shortfalls that might potentially spill over into FY17. We understand that these positive developments, being the new projects, are already crystalizing as sealed deals. Note that these will be awarded by existing and new customers. Even with our conservative new sales assumption, which is half the value from the potential projects (that will commence in FY17 on gradual basis), it is already offsetting the sales contribution from existing STB customers. We understand that no major capex will be incurred as the existing facilities are sufficient to take up the orders.

Maintain OUTPERFORM with an unchanged TP of RM2.40 (based on a targeted PER of 15.0x). Post-meeting, we have upgraded our FY16E CNP by 18% to reverse our overly pessimistic margins assumption for 4Q16. Meanwhile, we made no changes to our FY17E NP for now. The group’s superior margins, advanced manufacturing capabilities as well as strong parentage support from Foxconn Technology Group remained as key investment merits. Risks to our call; (i) slower-than-expected sales, (ii) loss of orders from its key customers, (iii) labour issues, and (iv) adverse currency translations.

Source: Kenanga Research - 23 Nov 2016